CHAPTER 5
Elasticity
PowerPoint® Slides
by Can Erbil and Gustavo Indart
© 2005 Worth Publishers
© 2005 Worth Publishers, all rights
reserved
Slide
5-1
What You Will Learn in This
Chapter:




What is the definition of elasticity?
What is the meaning and importance of
 price elasticity of demand?
 income elasticity of demand?
 price elasticity of supply?
What factors influence the size of these various
elasticities?
How does elasticity affect the incidence of a tax, the
measure of who bears its burden?
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Slide 5-2
Defining Price Elasticity of Demand
The price elasticity of demand is the ratio of
the percent change in the quantity demanded to
the percent change in the price as we move
along the demand curve.
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Slide 5-3
Measuring the Price Elasticity of
Demand
where
and
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Slide 5-4
The World Demand for Oil
When price rises to $21 per
barrel, world demand falls to
9.9 million barrels per day
(point B).
At a price of $20 per barrel,
the world quantity of oil
demanded is 10 million
barrels per day (point A).
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Slide 5-5
Calculating the Price Elasticity of
Demand for Oil
=
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Slide 5-6
Using the Midpoint Method to
Calculate Elasticities
The midpoint method is a technique for
calculating the percent change. In this approach,
we calculate changes in a variable compared with
the average, or midpoint, of the starting and final
values.
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Slide 5-7
Using the Midpoint Method to
Calculate Elasticities
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Slide 5-8
Using the Midpoint Method to Calculate
Elasticities – Numerical Example
= 20%
= 20%
=1
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Slide 5-9
Some Estimated Price Elasticities of
Demand
Good
Price elasticity
Inelastic demand
Eggs
Beef
Stationery
Gasoline
0.1
0.4
0.5
0.5
Price elasticity of
demand < 1
1.2
2.3
2.4
4.1
Price elasticity of
demand > 1
Elastic demand
Housing
Restaurant meals
Airline travel
Foreign travel
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Slide 5-10
Interpreting the Price Elasticity of
Demand: How Elastic is Elastic?
Two Extreme Cases of Price Elasticity of
Demand


Demand is perfectly inelastic when the quantity
demanded does not respond at all to the price
When demand is perfectly inelastic, the demand
curve is a vertical line
Demand is perfectly elastic when any price increase
will cause the quantity demanded to drop to zero
When demand is perfectly elastic, the demand
curve is a horizontal line
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Slide 5-11
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Slide 5-12
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Slide 5-13
Interpreting the Price Elasticity of
Demand: How Elastic is Elastic?
Unit-Elastic Demand, Inelastic Demand,
and Elastic Demand
Demand is elastic if the price elasticity of demand
is greater than 1, inelastic if the price elasticity of
demand is less than 1, and unit-elastic if the price
elasticity of demand is exactly 1.
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Slide 5-14
Highway department
charges for crossing a
bridge
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Slide 5-15
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Slide 5-17
Why Does It Matter Whether
Demand is Unit-elastic, Inelastic,
or Elastic?


Because this classification predicts how changes in the
price of a good will affect the total revenue earned by
producers from the sale of that good
The total revenue is defined as the total value of
sales of a good, i.e.,
Total revenue = Price × quantity sold
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Slide 5-18
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Slide 5-19
Elasticity and Total Revenue
When a seller raises the price of a good, there are two
countervailing effects in action (except in the rare case of
a good with perfectly elastic or perfectly inelastic
demand):

A price effect: After a price increase, each unit sold

A sales effect: After a price increase, fewer units are
sells at a higher price, which tends to raise revenue
sold, which tends to lower revenue
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Slide 5-20
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Slide 5-21
Elasticity and Total Revenue



If demand for a good is elastic (the price elasticity of demand
is greater than 1), an increase in price reduces total revenue
 In this case, the sales effect is stronger than the price
effect
If demand for a good is inelastic (the price elasticity of
demand is less than 1), a higher price increases total revenue
 In this case, the price effect is stronger than the sales
effect
If demand for a good is unit-elastic (the price elasticity of
demand is 1), an increase in price does not change total
revenue
 In this case, the sales effect and the price effect exactly
offset each other
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Slide 5-22
The Price
Elasticity of
Demand Changes
Along the Demand
Curve
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Slide 5-23
What Factors Determine the
Price Elasticity of Demand?

Whether Close Substitutes Are Available

Whether the Good Is a Necessity or a Luxury

Time
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Slide 5-24
Other Demand Elasticities:
Cross-Price Elasticity
The cross-price elasticity of demand between two
goods measures the effect of the change in one good’s
price on the quantity demanded of the other good

It is equal to the percent change in the quantity
demanded of one good divided by the percent change in
the other good’s price

The Cross-Price Elasticity of Demand Between
Goods A and B:
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Slide 5-25
Cross-Price Elasticity


Goods are substitutes when the cross-price
elasticity of demand is positive
Goods are complements when the cross-price
elasticity of demand is negative
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Slide 5-26
The Income Elasticity of Demand
The income elasticity of demand is the percent
change in the quantity of a good demanded when a
consumer’s income changes divided by the percent
change in the consumer’s income.
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Slide 5-27
Normal Goods and Inferior Goods


When the income elasticity of demand is positive,
the good is a normal good — that is, the quantity
demanded at any given price increases as income
increases
When the income elasticity of demand is negative,
the good is an inferior good — that is, the quantity
demanded at any given price decreases as income
increases
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Slide 5-28
Measuring the Price Elasticity of
Supply
The price elasticity of supply is a measure of
the responsiveness of the quantity of a good
supplied to the price of that good. It is the ratio of
the percent change in the quantity supplied to the
percent change in the price as we move along the
supply curve.
Next two slides: Two Extreme Cases of Price Elasticity of
Supply…
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Slide 5-29
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Slide 5-30
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Slide 5-31
What Factors Determine the Price
Elasticity of Supply?
The Availability of Inputs: The price elasticity of
supply tends to be large when inputs are easily
available. It tends to be small when inputs are difficult
to obtain.

Time: The price elasticity of supply tends to become
larger as producers have more time to respond to a
price change. This means that the long-run price
elasticity of supply is often higher than the short-run
elasticity.

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Slide 5-32
Economics in Action:
“European Farm Surpluses”
The imposition of price floors to support the incomes of
farmers has created “butter mountains” and “wine lakes” in
Europe
 Were European politicians unaware that their price floors
would create huge surpluses?
 They probably knew that surpluses would arise, but
underestimated the price elasticity of agricultural supply due
to availability of inputs
 They thought big increases in production were unlikely
since there was little new land available in Europe for
cultivation. However, farm production could expand by adding
other resources, especially fertilizer and pesticides. So
although farm acreage didn’t increase much, farm production
did!

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Slide 5-33
Elasticity and the Incidence of
Excise Tax


When the price elasticity of demand is higher than the
price elasticity of supply, an excise tax falls mainly on
the producers
When the price elasticity of supply is higher than the
price elasticity of demand, an excise tax falls mainly on
consumers
So elasticity—not who literally pays the tax—
determines the incidence of an excise tax
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Slide 5-34
An Excise Tax Paid Mainly by
Consumers
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Slide 5-35
An Excise Tax Paid Mainly by
Producers
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Slide 5-36
The End of Chapter 5
Coming Attraction:
Chapter 6:
Consumer and Producer Surplus
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Slide 5-37